Developed Stock Market Integration: New Evidence from the Pre- and Post-Financial Crisis of 2007-2009

Abstract

This paper studies the interdependence between the U.S. and four other developed stock markets in Canada, Japan, Sweden, and the UK. Specifically, we investigate how the 2007-2009 financial crisis influenced the dynamics of stock market integration among five developed countries by analyzing the short-run and long-run effects of the crisis over two sample periods: pre-crisis and post-crisis. We employ the Johansen co-integration test to verify cointegration and the Vector Error Correction Model (VECM) to examine the short-run and long-run relationships among five national stock markets. The results of co-integration tests confirm the presence of co-integration in both sample periods. The short-run VECM results indicate a significant influence of the U.S. market on four other markets in both periods, suggesting that little diversification benefits exist in the short-run. The pre-crisis long-run results demonstrate significant cointegrating relationships between the U.S. market and each of three markets (in Canada, Japan, and Sweden). The insignificant cointegrating relationship between the UK and U.S. markets in the pre-crisis period, however, becomes significant in the post-crisis period. In contrast, the Japanese stock market, which was initially cointegrated with the U.S. market in the pre-crisis period, loses its cointegrating relationship with the U.S. market in the post-crisis period. Overall, our findings confirm that major national equity markets are, to varying degrees, interdependent in both the short-run and long-run. We also find that a negative shock such as a financial crisis may significantly change the co-movements among national stock markets.